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Retirees face unpleasant taxes on Medicare

Karl Frank recently published an article in Retirement Investor about an unpleasant surtax for some retirees. Read this post to learn more about the Medicare surtax that might surprise you.

One of the least pleasant surprises in retirement is to find out that you suddenly have to pay more for Medicare than you expected. In this article, we discuss how and why this happens and what a retiree can do about it.

Jim and Jane ran a successful company together for more than thirty years. Their business was hit hard with a decline in tourism during the financial crisis of 2008. Then again, hit by the pandemic in 2020. They decided enough was enough and were ready to sell their business in 2022 and finally retire, full-time. They met with their financial planner and came up with a reasonable retirement income plan, based off their savings plus the proceeds from the business. They had a budget, a set of financial goals and they were excited to enter the next stage of life. They knew they would have to pay a tax on the one-time sale of their business, and they were comfortable with the after-tax amount, even if they blanched at the size of that tax bill.

But then things changed. Their financial planner introduced them to a surprise surtax called IRMAA: Income-Related Monthly Adjustment Amount. Because their income would increase the year they sold their business, they would have to pay a surtax.

When Jim found out about this surtax, he became irate. “You mean I work hard my whole life, and build up a business, but then when I want to sell it and retire off the proceeds, the government takes it back from me? For two more years, I have to pay more for Medicare than someone else who made the same amount of money as I did, but did not own a business?”

The Medicare Surtax

Retirees age 65 and older receive three types of Medicare insurance from the Federal government. Medicare Part A pays for hospital stays. Part B pays for outpatient services, medical equipment and preventative care. Part B is what most people think of when they talk about Medicare. Medicare part D covers the drugs- medicine–that a retiree may use. Part D premiums are paid to an insurance provider. Premiums for Part B come directly out of a person’s Social Security Retirement Income.

Medicare is an inexpensive insurance premium for most Americans. But for those who have high incomes, the costs of Medicare increase. The Federal government looks at a person’s Modified Adjusted Gross Income. On a tax return, the AGI (Adjusted Gross Income) is easy to find. On the 1040 for 2021, AGI appears on line 17 on the second page. For purposes of the Medicare Surtax, you must add any tax exempt income you receive, for example, from municipal bonds.

Jim and Jane have an average income and expected a modest retirement. However, because they had a year where the sale of their business gave them a high MAGI, they are looking at paying significantly more for the same Medicare benefits than if they had kept their business and not sold it.

IRMAA Income Limits

For retirees who are single or married filing separately, the first IRMAA adjustment happens at $91,000 of income for the year 2020. Medicare looks back two years, so beginning in the year 2022 retirees with incomes more than $91,000 will pay more for Medicare Part B and Part D. There are a series of 5 income brackets. Individuals hit the highest bracket at $500,000 or more income.

For married retirees, IRMAA begins at $182,000 of income. Married retirees hit the highest bracket at $750,000 or more income. In the case of Jim and Jane, the additional income from the sale of their business puts them above that number. Even though they only hit it once, in a single year, they have to pay the additional Medicare surtax on both Part B and Part D for two more years.

Click here for the complete chart

IRMAA Surtax Costs

The surtax increases the cost of Medicare Part B by as much as 385%. Couples who file Married Filing Joint (MFJ) with incomes under $182k pay $170.10. Single filers with under $91k income also pay $170.10. MFJ with incomes over $750k and single filers with $500k of income pay an additional $578.30 per month. Married filing separately hit the highest bracket at $91,000 of income. This is one reason to change your tax filing status.

But this is not the only surtax. Medicare Part D is paid directly to an insurer, but not the surtax. The surtax on Part D comes directly out of the Social Security Retirement Income check. This amount is as high as $77.90 per month, per retiree. This means the effective increase in taxes for Jim and Jane is 385% higher. That, says Jim, “just rubs me the wrong way.”

Click here for the complete chart

What can you do to avoid IRMAA?

The first thing Jim and Jane can do is not file married filing separately. If you lived with your spouse in 2020, and you are filing separately in 2022, then you hit the higher brackets at $91,000 of income. This means that you are paying more than three times as much for the same benefit as you would if you would file a married filing joint return.

The second thing Jim and Jane could do, if they have time, is to plan the business sale. They could sell the business at least  before they start taking Medicare. As long as the windfall year happens two years before Medicare, then the IRMAA surtax is avoided. Relatedly, they could plan the business sale as an instalment sale, over several years. If the business was sold in December, but half the payments were received in January of the following year, then they have cut their MAGI in half. For a very small business, that may be sufficient. For larger businesses, many years of payments may help.

How-to: Appeal an IRMAA 

The third thing that Jim and Jane could, and should, do is to file for a waiver. Affected clients often appeal an IRMAA, which is filed with Form SSA-44, “Medicare Income-Related Monthly Adjustment Amount—Life-Changing Event.” Legitimate life-changing events include marriage or divorce, bankruptcy, the death of a spouse, one spouse stopping work or having hours reduced, or the loss of an income-producing property to a disaster. One of the valid reasons for a waiver includes a decline in income due to stopping work. In Jim and Jane’s case, they can argue that their income went to zero after the business was sold. This should be done with the prior mentioned Form SSA-44, which is explained in detail below: 

Download form SSA-44 from the Social Security Administration and petition to have the surtax waived. 

Filled-out example Form SSA-44 is provided  

  1. Determine life changing events, include type and date of event 
  2. Enter adjusted gross income, tax exempt interest, and filing status for the tax year affected by the life-changing event  
  3.  IF modified adjusted gross income (AGI + tax-exempt interest) is less in the following year than in Step 2, input new amounts into step 3 
  4. Provide proper documentation for both MAGI and life-changing events  
  5.  Review, sign and submit to preferred Social Security Office 

*For submission you may either mail to your local Social Security Office or take it in person (office locator by ZIP code). 

Finally, Jim and Jane will work with their financial planner to make sure they include the additional costs in their retirement income plans. In fact, says Jim, he may ask for an additional amount of money from the buyer of his business to cover the Medicare surtax.

One final note that may feel like “salt in the wound,” a Medicare surtax may last for as many as two years even if you have a single-year windfall. The reason is that Medicare sends out the IRMAA determination letter at any point in time. Medicare does not have to hit a tax-filing deadline. An example may help. Let’s say have had a windfall three years ago for a single year. Last year you received your Initial IRMAA determination letter, and this year you expect that because your income from two years ago was lower than the windfall, your IRMAA is also lower (or completely gone). However, the IRMAA letter does not arrive and your surtax is still paid. In this case, you will want to file for the SSA-44 waiver.

In Conclusion

The Medicare surtax is a painful surprise for many retirees. Medicare looks back at income from two years previous and assess as much as a 385% surtax on premiums for two more years. Tax filers can petition to have the surtax waived. Medicare includes business sale, and other one-time windfall income, as well as tax-exempt income when calculating the Medicare surtax.

For Jim and Jane, they feel a lot better having a plan in place. Two years from now, it would be a difficult to pay more than three times as much for the same insurance benefit. Jim and Jane will petition to have the surtax removed.

As always, we thank you for your trust, and we welcome questions you may have about the investment landscape or your portfolio.
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About the author

Karl Frank, Certified Financial Planner ®, MSF, MBA, MA, is the President of A&I Financial Services LLC, a local business that specializes in wealth management, insurance planning, and retirement planning. Karl cares for business owners and the businesses that care for them. Learn More about Karl.